The Incomplete Competition Model

The dynamic version of the ICM is presented in Chapters 5 and 6 and an example of empirical estimation is discussed in greater detail within the frame­work of a small econometric model for Norway in Chapter 9 (Section 9.2). We shall therefore be brief in the outline of the ICM for the Euro area; details are given in Jansen (2004).

The econometric approach follows a stepwise procedure, where the outcome can be seen as a product of interpretation and formal testing: we first consider an information set of wages, prices, and an appropriate selection of conditioning variables like the output gap, unemployment, productivity, import prices, etc. It turns out that the data rejects the long-run restrictions from theory in this case. Only when we model the long-run steady-state equations with prices and unit labour costs as the endogenous variables do we find empirical support for the theory restrictions. The final outcome is steady-state equations of the following restricted form:

ulct = pt — wut, (8.10)

pt = (1 - ф)иС + фpit + t3t, (8.11)

where t3t is indirect taxes. We note that only two parameters, w and ф, enter unrestrictedly in (8.10) and (8.11).

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